One of the biggest fears for many people who invest in Wall Street and the stock market is seeing their money evaporate in a giant scam. It may take the average person years of work to accumulate enough money that could be used to invest in stocks. All those years of effort may disappear in a second if the money falls into the hands of thieves and schemers. There is no guarantee in life when it comes to handing money over to another party. One can hope that the recipient plans to use the money for legitimate ends. But it takes years to develop that sixth sense that “something is off” with a particular investment. Many times it is only hindsight that shows the indicators of a scam – indicators that were difficult to detect while the scam was ongoing. One such famous case was the collapse of Enron.
Breakdown of Enron’s Fraud
Enron was a giant energy company based in Houston. It started in the mid-1980s when two smaller companies were merged to form a bigger one. Over the years, Enron expanded its operations by acquiring domestic utilities and investing overseas. By the late 1990s, Enron was perceived as a giant player in the energy sector.
Perceived is a key word however in that Enron’s financial might and profitability was actually an elaborate fraud. Executives at the company fudged the books by claiming that all future revenue of multi-year contracts was actually one giant payment to Enron at the beginning. This would be equivalent to a person taking a job and saying they were paid their entire salary upfront even though they did not do all the work yet. Well, if the person is fired before the job is complete, they’re not going to get paid any money after being terminated.
This was the problem that Enron faced. While Enron immediately claimed all the future revenue from a contract, sometimes those contracts were not paid in full. This meant that Enron would have to revise their books and claim a loss. But rather than honestly claiming the losses, the executives at Enron instead set up fake entities to hide the losses. Everyone buying Enron stock were led to believe that Enron was extremely profitable, when in reality the company was hiding hundreds of millions of dollars in losses.
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Eventually this fraud became quite public in 2001 when Enron filed for bankruptcy, costing thousands of employees their jobs and many shareholders billions of dollars in lost investments.
The criminals that masterminded this fraud were eventually charged and convicted of serious crimes. Two of them spent many years in prison, while the third died before being sentenced to what would have been up to thirty years in prison. Their names will not be published here. However, one lesson for investors to keep in mind when deciding where to place their money is that two types of executives exist. The first type of executive tries to generate wealth by creating new products or services. The second type of executive gives the illusion of generating wealth by shuffling money around. The Enron executives most definitively belong in this latter group.
One of the side effects of the Enron scandal was the destruction of the “Big Five” accounting firm, Arthur Andersen. This firm was Enron’s outside auditor and was scrutinized for allowing Enron’s fraud to go unreported. But it was really Arthur Andersen’s shredding of documents related to Enron that resulted in it being convicted of obstruction of justice. Although that conviction was later overturned by the Supreme Court, the damage was done.
Sarbanes Oxley (SOX)
One of the positive outcomes of the Enron scandal was the passage of the Sarbanes Oxley Act (SOX). This law was passed to hold corporate boards more responsible for financial reports and accounting firms more independent when auditing their clients. SOX is one of the most intensive corporate responsibility pieces of legislation passed in the modern day – and it is one of the lasting legacies of the Enron collapse.